Stock Options, Equalization Payments, and Support Obligations
Stock options are a form of non-cash incentive compensation for executives and directors to motivate strong service to the company and loyalty to corporate goals. This compensation is speculative in nature whether granted by public or private companies.
They can also have a profound impact on the equalization payment arising from the property division scheme of married spouses and for parents entitled to receive child and spousal support.
Each call option has a set fixed exercise or strike price to be sold on or before a non-variable expiry date. For each call option, there is a premium for assuming the risk that they will be forced to sell the option at a price below fair market value.
Executives may realize a nil value on this speculative aspect of their compensation or they may realize significant gains. At any point from the granting of the options to the strike date, the options have value.
The unpredictable value of the options can be traced to a number of factors. One such factor relates to the underlying security and its prevailing market price at the time the option is granted. The stock’s slow growth or short-term cycles of volatility will require the employer’s patience and close monitoring inducing or delaying exercising the options with the given exercise period.
Another factor affecting the value of the option is its expiry date. Long exercise periods or strike dates may benefit from the growth of the company. If the value of the underlying security reaches or surpasses the strike price prior to the expiry date, the option is “in the money” and the holder will benefit financially. Conversely, if the option is not “in the money” as the exercise date draws near the options may be of little value.
A third factor affecting the value of the options is its direct connection to continued employment of the holder for the duration of the exercise period. The termination of employment also triggers the termination of the compensation package. The options will not vest and the employee will likely receive no financial benefit pursuant to the terms of the remuneration contract.
Family Law Implications
In Ontario, family law stock options are property assets to be valued within the equalization of net family property scheme for married couples. The proper valuation method is Black-Scholes calculation subject to, among other possible considerations, an applicable discount for the non-transferability of private company options and federal and provincial tax consequences. In addition, options are income assets for the purposes of determining child and spousal support.
Let’s consider an example: the executive pays $nil for the options granted by their employer as part of their compensation contract. The strike price is set at $100.00 and the fair market value when the option is exercised is $150.00. The net gain to the executive is $150.00 ($150.00 FMV – $nil purchase price). Of that gain, $100.00 is taxable employment income and $50.00 is subject to capital gains taxation.
The employment income is reported by the employer on the executive’s annual T-4 Statement of Remuneration and will be accounted for in line 150 of the executive’s T-1 General Tax Return in the year the options are exercised (not the year of issue). The capital gains will also be captured in line 150, income from all sources. Copies of complete filed income tax returns are exchanged between former spouses every year pursuant to the Child Support Guidelines financial disclosure provisions where a support obligation exists pursuant to an arbitration award, court order, or separation agreement.
Take note of actions which impact equalization payments and support:
- Voluntary or sudden termination of the executive’s employment where stock options are a part of the compensation package
- Delay in or refusal to exercise options where there is strong upturn in the value of the underlying security prior to the strike date
- Exercising the options during a significant or prolonged downturn of the market
- Refusal or failure to exercise the option allowing the option grant(s) to lapse
- Reasons for deferred income and choice of being granted options over salary
First steps to take:
- Don’t make assumptions there may be a reasonable explanation underlying the action taken; obtain full disclosure and ask questions.
- Early in the separation process jointly retain a qualified business valuator (CBV) to value the options with access to interview company staff and receive further disclosure as required. The value of the options will be shared by both spouses and the income supports the children and or spouse in need.
- Request / provide full disclosure of the executive’s complete current compensation package including schedule and status of all options grants as well as any possible future changes to remuneration.
- Examine the compensation package of the subsequent employer or reasons for a move to self
Lorisa Stein is a senior Toronto lawyer who frequently works with clients in need of sound legal advice regarding stock options, equalization payments and support obligations as they pertain to family law issues. To schedule a confidential consultation, please call (416) 596-8081 or email firstname.lastname@example.org. Alternatively, an appointment may be scheduled via the confidential contact form.